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Issues in Pension Program Management
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Issues in Pension Program Issues in Pension Program ManagementManagement
June 14, 2004June 14, 2004
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OverviewOverview
Overview of the Universities pension landscape
Risk management
Governance
The Universities’ Forum
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The Pension LandscapeThe Pension Landscape
TerminologyDB = Defined Benefit
Promise is a monthly pension Determined by formula typically based on
service and earningsTypically risk rests with the sponsor
DC = Defined Contribution Promise is specified contributionAccumulates with investment returnsLump sum value at retirementRisk rests with the member
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Pension Plan Income Replacement Pension Plan Income Replacement RatiosRatios
Historical Comparison of Pensions Provided UnderDefined Contribution and Defined Benefit Pension Plans
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
1957
1959
1961
1963
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
Year of Retirement
% o
f F
inal
Yea
r's
Sal
ary
Defined Benefit
Defined Contribution
Assumptions: - Retirement at age 60 - 30 years of service - 50/50 bond/stock mix (money purchase)
- Annual DC contributions of 10% of salary - Defined benefit formula = 1.47% of final average 5 years' salary - Pensions are non-indexed
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The Pension LandscapeThe Pension Landscape
Basic history over the last 15 years: Federal and provincial pension legislation reform in mid
1980s through early 1990s resulting in: Increased minimum funding requirements Limited RRSP room for many DB participants Maximum transfer limits for DB plans Maximum surplus limits in DB plans No guidance on surplus ownership Maximum pension limits that were frozen until 2004 Different (yet similar) minimum standards legislation
across each provincial jurisdiction
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The Pension LandscapeThe Pension Landscape
Basic history over last 15 years (cont’d)Strong investment returns from equity markets
and falling interest rates through most of the 1990s resulting in:
surpluses in DB plansDC plans appealing to employees – more
conversion to DC primarily in the private sector
disputes over surplus ownershipContribution holidays / improved DB benefits
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The Pension LandscapeThe Pension Landscape
Basic history over last 15 years (cont’d)Market setback in 2001-2002 with interest rates
remaining low resulting in:Disenchanted DC participantsDisenchanted DB sponsors
– Significant deficit issues– Forced into benefit improvements /
contribution holidays when surplus too high
– Benefit promises are unaffordable in many cases
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The Pension LandscapeThe Pension Landscape
Basic history over last 15 years (cont’d) On top of all of this:
Complexity of having to deal with 11 different legislative jurisdictions
Rising administration costs Need to implement supplemental plans for executives
and quite possibly middle managers Demands for improved pension governance Increased fiduciary liability concerns especially
around DC plans Limited flexibility for phased retirement
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The Pension LandscapeThe Pension Landscape
Sponsors questioning why they are sponsoring a pension plan?
Becoming an increasingly important element of an employee’s compensation
Proponents of a looming labour shortage forsee the importance that pension plans will play in recruiting and retaining key talent
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The Pension LandscapeThe Pension Landscape
Within University circles, the influence of the past 15 years has resulted in many different combinations of plan designs:
DC with / without investment optionsDC without investment options and DB
minimumDB with a DC minimumTraditional DB with various forms of risk
sharingConverted Plan – closed DB and DC for new
hires
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The Pension LandscapeThe Pension Landscape
Challenges associated with University plan designs General:
Is the pension deal clear and fair Past use of surpluses to improve benefits
DC with / without investment options Adequacy of benefits Education – liability for bad decisions
DC without investment options and DB minimum Adequacy of benefits better Costs of DB minimum can be volatile Liability associated with offering single DC fund
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The Pension LandscapeThe Pension Landscape
Challenges associated with University plan designsDB with a DC minimum
More “tools” to manage cost volatility but costs can be significant
Impact of maximum transfer limitsTraditional DB with various forms of risk
sharingSignificant costs (regardless of who pays)
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The Pension LandscapeThe Pension Landscape
Challenges associated with University plan designsConverted Plan – closed DB and DC for new
hiresDC challenges – adequacy of benefits and
educationAdded DB challenges:
– evolution of the investment policy– evaluation of the current financial position– the surplus tontine
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Risk ManagementRisk Management
Risk management has become an important focus in past five years:
Old risks become materialNew risks emerge
Approaches to pension risk management are evolving:
no risk managementidentifyingevaluating
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What are the Risks?What are the Risks?
Traditional measures of risk have been: Fluctuating contribution rates Deficits and additional funding Deficits and reduced benefits
Risks that are gaining much more attention: Excess surplus and having to improve benefits
Thin line between being conservative and creating intergenerational inequities
Legal liability - not fulfilling fiduciary responsibility Inadequate pension incomes
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What are the Risks?What are the Risks?
Key financial related risk measures are influenced by: Hiring practices Investment performance Asset / liability mismatch Early retirement programs Longevity
Key fiduciary liability related risk measures are influenced by: Governance practices Administration Member communication
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Approaches to Managing RiskApproaches to Managing Risk
IdentificationEducation – increasing awarenessShifting priorities from transactional to strategicControlling expectations – defining the
“pension deal” or who should bear the risk
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Approaches to Managing RiskApproaches to Managing Risk
QuantifyingEvaluation of margins in assumptionsEfficient frontier analysis for investmentsStochastic modeling or projected valuations of
financial factorsModels impact on plan of repeating history
into future under different benefit, funding and investment polices
Obtaining legal opinionsBenchmarking practices
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Approaches to Managing RiskApproaches to Managing Risk
EvaluatingExamining all pension risks in a holistic fashionAssessing reserves – both within and external
to the pension planEvaluating pension risks in context with other
non-pension risksContrasting pension risks to benefits
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Approaches to Managing RiskApproaches to Managing Risk
Organizations have typically “signed-on” for identification
Many are or have moved forward to quantification
Most struggling with evaluation due in large part to:pension risks only recently creating concernsManaging of pension risks are often viewed as
being “external” to the sponsor
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Approaches to Managing RiskApproaches to Managing Risk
Generally, organizations find pension risks harder to manage because:
Longer tail liabilitiesConflicting expectationsFiduciary responsibility – may differ from
institution’s objectives
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Evolution of DC Risk ManagementEvolution of DC Risk Management
Increase in DC plans has introduced a different set of risks that need to be managed
Risks with which DC sponsors currently struggle:Where to reside on the communication
continuum (I.e. information vs. education vs. advice)
Where to reside on the investment continuum (I.e. the degree of investment choice to offer)
Level of risk passed on to employees
Recent CAP guidelines expected to help clarify (?)
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GovernanceGovernance
Significant attention now being paid to pension plan governance
A result of similar factors giving rise to increased focus on corporate governance
Added dimension stemming from fiduciary responsibility recognized in statute and trust law
Current state: General concern expressed by regulators Guidelines established for industry standard Self assessment and regular governance reviews
becoming common place
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GovernanceGovernance
Issues being encountered:Assessment and review can be perceived to be
overwhelmingRealigning risks with controlExpense controlEnhancing investment structures
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Governance IssuesGovernance Issues
That “overwhelming feeling”: CAPSA guidelines are considered comprehensive
Roles / responsibilities / delegation Risk management / monitoring / objective setting Communication / information flow
Where “revolutionary” approach taken – concerns this may be adding to governance risks
Where “evolutionary” approach taken – concerns that evolution is not rapid enough
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Governance IssuesGovernance Issues
Realigning risks with control:Governance reviews can lead to a realization
that those taking the risks do not necessarily have appropriate control
Can lead to renegotiation and/or clarificationParticularly important in DC environments
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Governance IssuesGovernance Issues
Expense controlsExpenses paid from pension plan funds have
come under significant scrutinyGeneral rule - only expenses which result in
a direct benefit to the members can be paid from the plan
At the same time, sponsor costs are increasing as is desire for sponsor to charge plan for “services rendered”
Ambiguity surrounds expenses such as accounting costs, governance reviews and pension design
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Governance IssuesGovernance Issues
Enhancing Investment Structures: Growth of pension plan assets has led to “creative”
investment approaches Typically, investment policy is handled by a pension / HR
committee of the Board Consideration now being given to separating the pension
investment function from the broader pension governance framework
Theory is that it results in more effective investment management
Continued search for the “holy investment grail” – alternative investments, private placements, real estate, etc.
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Universities’ ForumUniversities’ Forum
Forum of pension plan reps from various Western Canadian Universities sponsored by Aon
Session took inventory of key pension issues currently being faced
Discussion of issues followed
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Universities’ ForumUniversities’ Forum
Key discussion points:Funding policy for DB plans
Maximum surplus limitsSustainability of current benefit and
contribution levelsCommunication and education policies
Information vs. education vs. AdviceFormal communication needs assessment -
none
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Universities’ ForumUniversities’ Forum
Key discussion points (cont’d)Investment policy
Asset Liability Management (ALM)Alternative investments – exploring but not
significant interest yetForeign investments – significant number
use derivatives to exceed cap – some as high as 45%
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Universities’ ForumUniversities’ Forum
Key discussion points (cont’d)Governance
Structure – significant diversityCommunication to membership – how much?Protecting the “volunteer”
DC liquidation strategiesSignificant interest in offering RRIF through
registered planUse of variable annuities – limited use in
future as no new ones can be setup
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Questions / Comments